CVP Analysis and Variable/Absorption Costing

For this mini-case, you will be tasked with conducting some cost-volume-profit (and related)

analysis, and will have an opportunity to practice communicating the results of that analysis in

written form. You are always welcome to discuss general course material with classmates and

others, but please be sure to complete this mini-case individually. Compile a document (PDF for

the final output, please) with your responses and work, and submit it via Canvas by the deadline

announced.

Kelly Kneppy owns a company that manufactures and sells camping equipment and outdoor

gear. Kellys latest creation is the Bear-B-Gone, a tent constructed of Kevlar and reinforced steel

mesh that could theoretically protect campers (who hadnt followed appropriate food storage

guidelines) from bear attacks. Kelly believes the Bear-B-Gone offers many of the same desirable

features as other tents on the market, and that this extreme safety feature will make it one of the

best-selling tents in short order.

Kelly can make the Bear-B-Gone with one of two available technologies. The first is a labor-

intensive process, that if chosen will require $600,000 per year in fixed overhead costs, and the

following in variable costs of production per unit: direct materials of $75, direct labor of $75,

and overhead of $20. The second technology is a more automated (machine-dependent) process,

that if chosen will require $2,000,000 per year in fixed overhead costs, and the following in

variable costs of production: direct materials of $75, direct labor of $5, and overhead of $60.

Kelly believes she can sell the tent for $200.

1) What is Kellys break-even point in units (and sales dollars) with the labor-intensive

production process? What is the break-even point in units (and sales dollars) with the

more automated process?

2) Which process is preferred if sales are expected to be 40,000 units? How about at 60,000

units? At what sales level would the two processes yield equivalent profit (round to the

nearest whole unit)?

3) Suppose possible sales are expected to range between 40,000 and 60,000 units as noted

above, and that production will equal sales (no beginning/ending inventory). Which

process has the greater range in profit? Why might this be a factor for Kelly to consider

in making her decision?

4) Assume sales were to fall at the midpoint of the projections above, 50,000 units.

Following up to the previous question, under which process would you say Kellys profit

is more sensitive to changes in demand (sales)? Why? Does this make one of the options

strictly better than the other? Why or why not?

5) Suppose Kelly decided to go with the labor-intensive process. Suppose also that, in the

first year of operations, Kelly produces 80,000 tents and sells 65,000. What is the unit

product cost of the tents under variable costing? Under absorption costing? If Kelly

prepared GAAP-compliant financial statements in order to share with potential investors,

would her over production make her appear more or less profitable (or no different) as

compared to if production had been equal to sales at 65,000 units?

6) What other factors might affect Kellys decision to focus on capital- vs. labor-intensive

processes? To get you started, consider things from earlier in this class

and outside of a strictly managerial accounting realm, such as taxes (or tax credits for certain business

operations), product quality, and public perception (using employees vs. automation). To

strengthen your response, you might wish to refer to a source or two from business or

popular press that illustrates how the factor(s) youre discussing affected a real

organization in a positive or negative manner.

7) Prepare a brief memo to Kelly, outlining your findings. You do not necessarily need to

include all of the numbers youve calculated above, but you should include anything

that you think would best convey the most important points of your analysis. Feel free to

include components that arent part of the formal requirements in items #1-6, if you deem

them critical.